An Initial Public Offering (IPO) is the means by which privately held companies transition into publicly traded companies. Hence the phrase, “taking a company public.” From an organizational standpoint, taking a company public is one of the biggest decisions a company’s board of directors will make in the company’s lifetime. The transition from a privately-held entity to a public one has a substantial impact on how the company operates.
An IPO is also one of the most tedious projects an investment banker will work on for a couple of reasons. For one, it requires coordination across a large team of involved parties: the company’s management, the company’s legal counsel, the company’s auditors, underwriters, and the underwriters’ legal counsel will all have a view on issues that impact each participant. This group of stakeholders must reach a consensus on every decision for the process to smoothly progress through each step. Also, the IPO process is tedious because of the vested interest of board members, company management, and company employees. The company’s board and management are likely not acting only as a fiduciary to shareholders, but participating in the process as shareholders too. Thus the board and management have a responsibility to act upon the best interest of all shareholders, but in some situations, this may run contrary to what is best for the board member or management executive individually. This “agent-principal” problem can lead to a lot of possible complications in the IPO process.
WHY CHOOSE TO “GO PUBLIC”?
There are several reasons that companies might decide to undergo an IPO, including:
1) Providing liquidity for a parent company or employees: Existing shareholders (generally employees, management, and board members, and often venture capital investors), use an IPO to monetize all or some of their equity stake. Without the IPO, it is often difficult to translate the “paper” value of the shareholders’ equity positions into cash, because it is difficult to sell the positions without a market for trading them.
2) Access to the capital markets: Proceeds raised through an IPO are not solely for the benefit of selling shareholders. Proceeds can be used to fund organic growth and expansion, retire existing debt, or expand capacity in other capital markets. All other things being equal, public companies have more financing alternatives available, including bank debt, senior debt, hybrid/mezzanine capital, or equity-linked alternatives.
3) Establishing a currency for growth: As stated, public companies have more funding alternatives available to manage operations and growth. One example of this is that publicly traded stock can relatively easily be used as a currency to fund acquisitions without using cash or incurring additional debt. The acquiring company simply exchanges its shares for the equity shares of the company being acquired. This not only fortifies the acquirer’s balance sheet, but also enables the target shareholders to participate in the anticipated upside of the combined company.
4) Establishing a transparent value for the enterprise: Following a successful IPO, the company’s board and management team will have a readily available measure with which to determine the value of the company, as well as compare it with that of other companies. Additionally, the board and management can now measure value creation over a defined time period, and compare it to the value creation of peer companies.
5) Branding/prestige: A public stock offering potentially strengthens visibility and name recognition for both current and new customers and stakeholders.
From start to finish, the IPO process generally takes about four months. This typical time frame includes any organizational structuring, due-diligence processes, legal documentation, investor marketing and pricing, and evaluation of market conditions. There are a few reasons the process could take longer, however.
Given that boards and management teams have a vested interest in maximizing proceeds, both for themselves as well as for the sake of all selling shareholders, market conditions can play a considerable role in determining timing. Directly following a market crash, for example, a company may decide it is not the best time to go public. As a result, in periods of significant market volatility, a substantial IPO backlog can develop. This was the case in the second half of 2008 and in 2009 following the financial crisis.
Additionally, an IPO might get held up by regulatory review. For example, the SEC’s review of the company’s registration statement may result in a large number of comments and changes that need to be addressed before the registration will be approved. This can delay finalizing an effective registration statement and prospectus.
The attached graphic displays the various elements of an IPO process, and the timing of those elements under normal conditions.